Section 40: Securities to Be Dealt with in Stock Exchange

The article focuses on section 40 of the companies act, 2013 which enumerates certain conditions that must be complied with, when a company is raising money, through public issue. Also, it is very important that the company must obtain permission from the stock exchange before making a public offer of the shares/ debentures. It also discusses about the important judicial pronouncements related to the same section.
Estimated Reading Time: 8 minutes

Introduction

Section 40 of Companies Act, 2013, part of chapter III, part I lays down the provision with respect to securities to be dealt with in the stock exchanges. This section was enforced vide notification dated 12th March 2013. The clause (6) of this section, dealing with commission to persons in connection with the subscription, was enforced on 1st April 2014. This section lays down certain conditions that must be complied with, when a company is raising money, through public issue. It is very important that the company must obtain permission from the stock exchange before making a public offer of the shares/ debentures. This is a section that mandates certain compliances that a company must adhere to, to make their public offer legitimate and valid. This analysis will provide a better understanding of such additional conditions on public offer by a company.

Purpose of Section 40

This section under the act, 2013 is quite brief and lays down following:

  • When any company makes a public offer, it must make an application to one or more recognized stock exchanges to get permission for listing its securities in the stock exchange. Where a prospectus states that an application to any stock exchanged for permission is made, it must state the name or names of the stock exchange in which the securities shall be dealt with. The requirement is not merely to apply but also to obtain permission.
  • All the monies received by the company from people who have subscribed to the company’s securities, have to be according to this section kept in a separate account by the company in a scheduled bank. This separated money cannot be used for any other purpose then following by the company: (a) where the securities have been permitted to be dealt with in the stock exchange, then for adjustment against allotment of securities (b) When the company is unable to allot securities, to repay the money back to the people who subscribed for the securities through application, as per the prospectus of the company.
  • There cannot be any contrary condition or requirement binding the applicant, applying for securities of the company, to do any with any of the requirements of this section. If such condition or requirement exists, they will be void as per this section.
  • If there is any default in compliance of this section, by the company, it will be punishable with fine not less than five lakh rupees to fifty lakh rupees and every officer in default of the company will liable and punished with imprisonment, which may extend to one year or with fine which will be from fifty thousand rupees to three lakh rupees or with both.
  • A company under this section, can pay to any person with subscription to its securities, after compliance of necessary conditions prescribed.

This section has to be read with Companies (Prospectus and Allotment of Securities) Rules, 2014, which provides for paying commission to any person in connection with the subscription to its securities, by the company, whether absolute or conditional, subject to the conditions as follows[1]:

  • The payment of such commission shall be authorized in the company’s articles of association. The articles of association of a company shall authorize payment of such commission by the company.
  • The proceeds of the issue or the company profit or both can be used by the company to pay the commission.
  • The rules also provide for the rate of commission, which shall not exceed in case of shares five percent of the price at which the shares are issued by the company, or such rate as authorized by articles of the company, whichever is less. In case of debentures, the rate shall not exceed two and a half percent of the price at which the debentures are issued by the company or such rate as provided by the articles of the company, whichever is less.

Following information has to be disclosed by any company in its prospectus (i) underwriter’s name (ii) commission payable to the underwriter, the rate and amount (iii) the number of securities which is to be underwritten or subscribed by the underwriter absolutely or conditionally.

A commission will not be paid to underwriters on securities when such securities are not offered to the public for subscription.

When the prospectus is delivered to the registrar for registration, it is mandatory that a copy of contract for the payment of commission is also delivered along with it.

Situation Before Enactment of Section 40

This section corresponds to section 73 and section 76 of the 1956 Act, which dealt with allotment of shares and debentures and power to pay commission. Section 40 (3) (b) of the new act, 2013 empower the SEBI to specify time, in which the monies received from applicant in pursuance of the prospectus, has to be refunded, whereas Section 73 of the old act, 1956 inter-alia provides that where the permission has not been granted for listing of securities/ not applied for, the company shall repay the monies collected from the applicants without interest within eight days after the company becomes liable to repay and in case of failure on the part of the company to do so, the company and every director who is a officer in default shall, on and from the expiry of the eight day, be jointly and severally liable to repay that money with interest which shall not be less than four per cent and not more than fifteen percent.

Under the old act, 1956 any excess money received from the applicants shall be refunded without interest within a period of eight days and in case of default the company and every director who is a officer in default shall be jointly and severally liable to repay that money with interest which shall not be less than four per cent and not more than fifteen percent. Penalties stand substantially increased in the new act, 2013 as seen from above discussion. Proviso to Section 73 (1A) of the old act, 1956 provides that where an appeal against the decision of any recognized stock exchange refusing permission for the shares or debentures to be dealt in on that stock exchange has been preferred, the allotment shall not be void until the dismissal of such appeal. There is no such provision in the new act, 2013. Under the new act, 2013 the company can pay commission to any person in connection with subscription of securities subject to conditions as prescribed under Rule 13 of the Companies (Prospectus and Allotment of Securities) Rules, 2014.

Application of Section 40

This section basically comes into application, when a company has to issue shares or debentures to the public through public offer, to raise money. This section provides some mandatory conditions that must be followed by companies issuing public offers, to constitute a valid offer. If the condition of permission from stock exchange(s) is not met, the issue would be considered void. This is a basic section that must be followed at the initial stages of a public offer by a company.

Cases at a Glance

Following are the cases pertaining to this section:

  • Rich Paints Ltd. v. Vadodara Stock Exchange Ltd[2]In this case the court held that application money has to be kept in a separate bank account and all money received on application from the public for subscription to the securities shall be kept in a separate bank account in a scheduled bank. It is banker to the issue and not any other bank where the amount collected on application money is to be kept.
  • Union of India v. Allied International Products Ltd [3]: The Supreme Court of India explained the object of this section in this case.  The objective is to enable shareholders to find a ready market for their shares so that they can convert their shares investment into cash whenever they like. The court held that even if one out of the several stock exchanges applied for and granted recognition it would be enough to validate the allotment; the facility of at least one stock exchange would be thereby available.
  • RBI v. Bank of Credit and Commerce International (Overseas) Ltd. [4]: In this case the court held that the advantage of listing is that shares become freely marketable and this enhances their value. The subscription money has been held to be trust money and not a part of the banker’s general assets so as to be usable in his insolvency. It is refundable in specie.
  • Radhey Shyam Khemka v. State of Bihar [5]: In this case the court held that the misuse if the money may amount to criminal breach of trust under Indian Penal Code, 1860 and punishable as such and further that the power of prosecution has been delegated to SEBI.
  • Herdillia Unimers Ltd. v. Arun Bansal[6] : This is another important case in which the court held that the offence involved in failure to dispatch refund warrants for a invalid public offer, is held to be wiped out where as soon as the failure was discovered and the default can be made good by sending duplicate refund warrants as soon as possible.
  • Sahara India Real Estate Corporation Ltd. v. SEBI [7]: This is a very important and famous case on public offer and private placement. Here the Supreme Court of India held that effect of the provision of section 73 of the companies act, 1956 (Similar to section 40 of the Companies act, 2013) is that the listing is mandatory and a default in this respect makes allotment of shares or debentures violative of this provision and therefore invalid/ void and thus the allottees moneys have to be refunded back to them with an interest of fifteen percent.

Concluding Summary

Section 40 is very important as any company, laying down that every company making a public offer must make an application to at least one stock exchange before making the public offer. A company cannot make a public offer without taking permission from at least one stock exchange. This is the duty of the company to obtain permission of stock exchange or stock exchanges for the dealing of securities there and it is also a duty to put all the monies collected by way of subscription in a separate bank account. This section provides for a ready market for the investors and shareholders, after subscription, so that they can attain profit from the marketability of the shares and thus this section in a way encourages investment.


[1] Companies (Prospectus and Allotment of Securities) Rules, 2014, r. 13 (MCA).

[2] Rich Paints Ltd. v. Vadodara Stock Exchange Ltd. (1998) 28 CLA 276 (GUJ.).

[3] Union of India v. Allied International Products Ltd. (1970) 3 SCC 594.

[4] RBI v. Bank of Credit and Commerce International (Overseas) Ltd. (1993) 78 CompCas 230 (BOM.).

[5] Radhyey Shyam Khemka v. State of Bihar (1993) 3 SCC 54.

[6] Herdilla Unimers Ltd. v. Arun Bansal (1999) 96 CompCas 521 (RAJ.).

[7] Sahara India Real Estate Corporation Ltd. v. SEBI (2013) 1 SCC 1.

Also read, Patent Infringement: exclusive rights to inventor, protection from violation.

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